Strategies Used by the Banking Industry to Mitigate Losses on Non-Performing Loans

Strategies Used by the Banking Industry to Mitigate Losses on Non-Performing Loans

In depressed economic times, Banking is an industry that is prone to substantial financial losses, from customer’s closing their depository account to an increase in outstanding loan delinquency. An increase in consumer and commercial loan defaults can damage the integrity of a Bank’s outstanding loan portfolio. Such deterioration can lead to an increase of “Non-Performing Assets”.

Once a loan is nonperforming, (usually when a debtor has not made their scheduled payment for at least 90 days, but there are other reasons why a loan can be deemed “non-performing”) the odds that it will be repaid in full are considered to be substantially lower. The non-performing asset is therefore not yielding any income to the lender in the form of principal and interest payments.

Banks have spent the last several years grappling with nonperforming assets, but perhaps working out problems with bad loans is best left to entities that do not have to answer to a Federal Regulator. This year, more banks have escalated efforts to sell nonperforming assets, and industry experts say the volume of such deals is only going to increase. Meanwhile, a new deal structure is calling for sellers to retain the problematic assets to work them out on their own. (Barba, 2011)

But, even if a loan pays in accordance with its Terms & Conditions, it still can be categorized non-performing for several reasons. Deterioration in financial ratios can cause a loan to be classified non-performing, one of those financial ratios is Loan to Value or “LTV”.

LTV is the outstanding principal balance of the loan divided by the appraised value for real property pledged as collateral for a loan. When the appraised value of the pledged collateral decreases faster than the principal of the loan, the LTV will increase, thereby making this loan a greater risk in case of default.

The benchmark LTV ratio will usually not exceed 75%, the rationale behind this threshold is if the loan does default and, subsequently, the asset disposed of, that the 25% of equity can be used to reimburse the bank for legal fees, court cost, and expenses incurred with liquidating the collateral. This strategy is incorporated in the bank’s lending policy in the effort to “make the bank whole” in a loan default scenario.

When the loan request is not collateral based, the key financial ratio used to determine the borrower’s ability to repay is Debt Service Coverage or DSC. This ratio is calculated using the existing company debt, plus the new loan obligation, divided by the businesses existing cash flow to determine if the total debt can be supported. Covenants in the loan documentation will require the business to furnish Tax Returns and Financial Statements annually to review the borrower’s financial condition to ensure sufficient DSC. If it is determined that the DSC is not sufficient or if the borrower is not in compliance of the Loan Covenant by not supplying the required financial information, the loan can be classified as non-performing.

An increase in the level of non-performing assets increases risk and impacts capital levels that regulators believe are appropriate in light of the ensuing risk in the loan portfolio. Regulators request that the level of non-performing assets be reduced. If these problem assets are not reduced through loan sales, workouts, or restructuring or the level of problem assets continue to rise through decreases in the value of the underlying collateral, or in these borrowers’ performance or financial condition, whether or not due to economic and market conditions beyond our control, could adversely affect the bank’s operations and financial condition. This is why banks are so interested in getting these assets off the books.

Banks that’ve held on to some loans in hopes of a rapidly increasing economic recovery are starting to lose hope. Moreover, the Euro...

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...Nonperforming loans (“NPLs”) refer to those financial assets from which banks no longer receive interest and/or installment payments as scheduled. They are known as non-performing because the loan ceases to “perform” or generate income for the bank. NPLs are viewed as a typical byproduct of financial crisis: they are not a main product of the lending function but rather an accidental occurrence of the lending process, one that has enormous potential to deepen the severity and duration of financial crisis and to complicate macro economic management. This is because NPLs can bring down investors’ confidence in the banking system, piling up unproductive economic resources even though depreciations are taken care of, and impeding the resource allocation process.
In a bank-centered financial system, NPLs can further thwart economic recovery by shrinking operating margin and eroding the capital base of the banks to advance new loans. This is sometimes referred to as “credit crunch”. In addition, NPLs, if created by the borrowers willingly and left unresolved, might act as a contagious financial malaise by driving good borrowers out of the financial market.
The economic and financial implications of NPLs in a bank-centered financial economy can be best explained by the following diagram:
Nonperforming
Loan (NPL)
Loss of
current
revenue
High
loan loss...

..., Dealing with non-performingloans of banks
ISHRAT HUSAIN
A lot of confusion and misunderstanding has been created by several
commentators on the issue of non-performingloans (NPLs) of banking system.
They take the absolute amount of such loans at the current point of time and
compare it with the quantum of such loans in October 1999 and make a hue and
cry that the situation has deteriorated because the quantum of NPLs has gone up.
Such a simplistic approach creates doubts in the minds of common people about
the commitment of the government and the State Bank of Pakistan towards
recovery of these loans and distorts the true picture about this important issue.
The aim of this article is to inform the public about the exact magnitude of
the problem, the trend over time and the measures the State Bank of Pakistan is
taking to tide over this problem.
The State Bank of Pakistan (SBP) is dealing with the NPL issue in a
comprehensive manner through (a) improvement in coverage and reporting of
NPLs (b) a proactive treatment of the existing stock of NPLs (c) stemming flow
of new NPLs and (d) improving the policy and regulatory environment.
2
It should be realized that the stock of existing NPLs will always grow over
time even if all the new loans being granted are fully serviced. This will happen
because...

...﻿ECON 434: MONEY AND BANKING II
[Type the company name]
GROUP MEMBERS
BOATENG GODWIN 10277955
BOSE-DUKER THEOPHILINE 10278103
BUGRE ABRAHAM 10278302
CANTREPH GEORGE 10278330
COMMODORE-MENSAH ESTHER 10278411
DANSO BRIGHT 10278628
1.0 INTRODUCTION
Lending is one of the main activities of banks in Ghana. This is evidenced by the volume of loans that constitute bank assets and the annual volume of credit granted to borrowers in the private and public sectors of the economy. Loans are therefore, typically, the largest and the most important asset and source of revenue for banks through significant interest income earnings. A survey in 2006 on the Ghanaian Banking Sector revealed that loans account for about 50% of total bank assets. In 2007, the figure increased to 53% of the industry’s total assets of GH₵7,795.60 million. (Infodata Associates, 2009).
The facts above give ample evidence that healthy loan portfolios are vital assets for banks in view of their positive impact on the performance of banks. Unfortunately, some of these loans do not perform and are defaulted and eventually result in bad debts which affect banks earning on such loans. These types of loans are on-performingloans or simply bad loans. In February, 2009, a Bank of Ghana report...

...Question 1:
Most of the financial institutions have the problem of non-performingloans. Basically, the non-performingloans (NPLs) mean that the loans in default, or is close to being in default according to Investopedia. In the contract terms, NPLs indicates the failure to promptly pay interest or principal when due. When the borrowers are unable to meet the legal obligation on making the required payment or are unwilling to honor the debt, the default will be taken place.
With the increase of NPLs, the level of market confidence will be affected. The effect of the banks’ bad-loan problems can be seen at the East Asian crisis which occurred in July 1997. During the crisis, banks’ balance sheets were deterioration due to the increasing of NPLs which showed in the Figure 1 below (Detragiache &amp; Gupta). The problem was started as the deregulation was exercised in the financial markets. A lot of loan borrowings from the private nonfinancial business sector were easily being approved. But, the bank regulators failed to supervise the borrowers as there was a lack of expertise in screening and monitoring the borrowers at banking institutions. Hence, the default loans started to increase and the banks’ net worth (capital) became lesser. The bank would have lesser fund to lend. Then, the economic activity would be...

...INTRODUCTION
1.1
Non-PerformingLoans(NPLs)
Non-performingloans (NPLs) can be defined as defaulted loans, which banks
are unable to profit from. Usually loans falls due if no interest has been paid in 90
days, but this may vary between different countries and actors. Defaulted loans
force banks to take certain measures in order to recover and securitize them in the
best way. (Ernst & Young, 2004) and there also the definition of impaired loans is
loans that have not expired, but it is uncertain whether the borrowers could repay
their debts. Generally banks and other credit institutes do not class them as
potential non-performingloans and therefore calculate with little or no loss provision
from them. (Ernst & Young, 2004)
The issue of non-performingloans (NPLs) has gained increasing attentions in
the last few decades. The immediate consequence of large amount of nonperforming loans in the banking system is bank failure. Many researches on the
cause of bank failures find that asset quality is a statistically significant predictor of
insolvency (Dermirgue-Kunt 1989, Barr and Siems 1994), and that failing banking
institutions always have high level of...

...Determinants of Non-PerformingLoans: The Case of Eurozone
vmakri@upatras.gr
Athanasios
Tsagkanos

UDC 336.77 (4-672EU) ”2000/2008”
DOI: 10.2298/PAN1402193M
Original scientific paper
bellas@upatras.gr
Acknowledgements: The authors
would like to thank the two anonymous
referees and the Editor for their
constructive comments and
suggestions that improved our paper.
We are also grateful to Dr.
Konstantinos Papadatos for his helpful
recommendations.
Summary: The purpose of the present study is to identify the factors affecting
the non-performingloans rate (NPL) of Eurozone’s banking systems for the
period 2000-2008, just before the beginning of the recession. In our days,
Eurozone is in the middle of an unprecedented financial crisis, calling into
question the soundness of the banking systems of European countries. Looking at both macro-variables (e.g. annual percentage growth rate of gross domestic product, public debt as % of gross domestic product, unemployment)
and micro-variables (e.g. loans to deposits ratio, return on assets, return on
equity), we investigate which factors determine NPL on aggregate level. Overall, our findings reveal strong correlations between NPL and various macroeconomic (public debt, unemployment, annual percentage growth rate of gross
domestic product) and bank-specific (capital...

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